Investing Education

The Dow Theory

Charles Henry Dow There are very few writings on technical analysis that have stood the test of time and truly deserve respect but the Dow Theory is unquestionably one of them.

Charles Dow was one of the true Pioneers of Technical Analysis; he even created the first stock index; The Dow Jones Industrial Average. In 1899 he published a series of editorials in the ‘Wall St Journal’ (which he also founded). These editorials became the basis of his now famous Dow Theory. Although many people today use his theory as the basis for market timing it was originally intended as a way to measure general business trends.

The Dow Theory consists of 6 parts

The Market Discounts Everything
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The market represents the most democratic indication of stock value. The price of a stock in a free, competitive market reflects all that is known, believed, surmised, hoped, or feared and therefore it combines the attitudes and opinions of all..
The Market Has Three Trends
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- The Primary Trend can be either Bullish or Bearish and tends to last from 1 to several years. Manipulation of the primary trend is not possible.
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- Secondary Trends are short corrections to the Primary Trend. They tend to last 1 – 3 months and retrace 1/3 – 2/3 of the last movement of the Primary Trend.
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- Minor Trends can last from a day to several weeks. At this time frame the market is subject to manipulation and can be misleading.
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Primary Trends Have Three Phases
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- Phase A is started by the Value Investors and the ‘Smart Money’ who begin to aggressively acquire stocks because their fundamental analysis indicates that the market is trading at a deep discount. This buying absorbs any excess supply and the bottom of the market is established. Even if the economy is still in bad shape, it is not as bad as stock prices would suggest so in the foreseeable future higher prices are inevitable..
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- Phase B – The sentiment during this period is of extreme pessimism – “The sky is falling and we are all doomed”. The Smart Money is like a kid in a candy store picking up exceptional companies at bargain prices (often below their intrinsic value). Slowly earnings increase and good news becomes the norm. The General Public is very cautious but begins to accumulate stock under the improving conditions.
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- Phase C – Is recognized by record earnings and perfect economic conditions. The general public (with a short memory for how they lost it all last time) starts taking investment advice from their Taxi Driver who just made killing off the latest IPO. Everyone (the general public) is certain that the market is headed for the Moon. This escalates into a buying frenzy; pushing prices to dizzying heights. Such lofty valuations cause the Smart Money to begin moving their money into safer areas in anticipation of the inevitable correction.
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  “Be fearful when others are greedy and to be greedy only when others are fearful.” – Warren Buffett
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The Averages Must Confirm Each Other
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Dow utilized two averages in his analysis; The Industrial Average and The Railroad Average (Now the Dow Transportation Index).In 1900 America was deep into the second Industrial Revolution which ran from about 1870 to 1914. During that time Railroads were of supreme importance to the increase of trade throughout the US. James Watt had recently improved the steam engine making it a viable piece of machinery.

Steam locomotives allowed for quicker transportation of raw materials that could be used to produce finished goods and the transcontinental railroad was completed in 1869. The US suddenly had a quick passage from east to west. A journey that used to be a 4 – 6 month trek could now be accomplished by train in just six days!

According to Dow’s Theory, a bull market in Industrials could not occur unless the Railroad Average rallied as well. This logic is very sound; railroad companies can only prosper when the economy is flourishing and increasing quantities of goods are being transported. If the Railroad stocks are struggling then manufactures must be producing less. This made Railroad stocks extremely economically sensitive.

Dow created the Industrial Average to be like a measure of the tide on one part of the beach, and the Railroad Average was a measure on another part. Used in conjunction they helped to determine that the tide was indeed coming in or going out all along the seashore, rather that being tricked by rogue waves on one part of the beach.

Dow observed that both averages must make higher highs to confirm a bull market and vice versa. When the performance of the two averages diverged he saw it as an indication that there was a change in the tide.
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Volume Confirms The Trend.
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Dow noted that volume should expand in the direction of the trend. Stronger volume should be seen on the days that the market is up in a bull market and down in a bear market.
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The Trend Remains Intact Until A Confirmed Reversal
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A bullish trend can be described as consecutive higher highs and higher lows. To change to a bearish trend it is necessary to have at least one lower high and a lower low. This trend change must then be confirmed by the Transportation Index to have the greatest chance of continuing.
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A Dow Theory For The Information Age

This is a theory written over 100 years ago before anyone had even heard of technical analysis, during a time before computers and charting software. It makes my head spin to think that Dow would have had to do all his charting by hand and if he was lucky he may have had the help of crude calculator the size of a suitcase. Yet it is amazing how timeless the principles he wrote about were and how valid they remain today. An understanding of these simple concepts is an invaluable foundation to effective technical analysis.

Apart from the way that Dow confirmed a trend reversal I agree with every aspect of his theory but the major difference today is that we have moved out of the Industrial Age and into the Information Age.

The invention of the micro processor making PCs affordable for the masses can be likened to James Watts improved steam engine making mass rail transportation a viable option. The way that the Internet opened up the global economy can be likened to how the transcontinental railroad in 1869 opened up ease of trade between the east and west of the US.

The Information Age has created a smaller, more integrated world where we already have the ability to work as a unit in real time. Communication, trade, employment, personal and commercial transactions are now occurring on a global scale. Largely, international and regional boundaries are being ignored; capital now flows far more freely between countries.

Profits in the Industrial Age came from economies of scale; factories and assembly lines. Now profits come from speed of innovation and the ability to attract and keep customers. In the new economy information is often the currency and the product.

In 1901 the biggest company in the world was U.S Steel with a market cap of approximately 35 billion in today’s dollars. Now, we have companies like Google that provide an electronic information service with no physical product. In November 2010 Google had a market cap of over 200 billion, six times that of U.S Steel in 1901.

Technology is at the forefront of the business cycle and semiconductors are at the forefront of technological advancement. All expansion requires semiconductors and any slowdown causes an expensive build up in inventory. Inventory that has a very short shelf life causing the Semis to feel the burn as soon as the business cycle begins to slow (a huge build up of inventory was seen leading up to the Tec bubble in 2000).

Semiconductors are the Railroads of the Information Age and are extremely economically sensitive. For this reason they play an integral part in identifying the markets true direction and why I use them along with the Transportation Index in a process I call ‘Holistic Market Analysis’. This is the process that I go through in the weekly ETF HQ Report (Subscribe Here For Free).

Essentially the Dow Theory looks for confirmation of the broad market trend from an economically sensitive industry at the front of the business cycle. Both Transportation and Semiconductors fit that criteria for now but perhaps in the future new Industries will evolve and take the lead.

Are you a believer in the Dow Theory? Have you had success or otherwise using it? What are some other industries that lead the business cycle? Share your thoughts in the comments section below.

The Dow Theory

There are very few writings on technical analysis that have stood the test of time and truly deserve respect but the Dow Theory is unquestionably one of them.

Charles Dow was one of the true Pioneers of Technical Analysis; he even created the Dow Jones Industrial Average, the worlds first Stock Index. In 1899 he wrote a series of editorials that that became the basis of his now famous Dow Theory in a paper he founded, called ‘The Wall Street Journal’. The articles were written with the intention of sharing a theory for measuring general business trends not for use as a market timing system.

The Dow Theory consists of 6 parts:

1. The market discounts everything

• The market represents the most democratic indication of stock value. The action of a stock in a free, competitive market reflects all that is known, believed, surmised, hoped, or feared and therefore it combines the attitudes and opinions of all.

2. The Market has three trends

• The Primary Trend can be either Bullish or Bearish and tends to last from 1 to several years. Manipulation of the primary trend is not possible.

• Secondary trends are short corrections to the Primary Trend. They tend to last 1 – 3 months and retrace 1/3 – 2/3 of the last movement of the Primary Trend.

• Minor Trends can last from a day to several weeks. At this time frame the market is subject to manipulation and can be misleading.

3. Primary Trends have three Phases

A. Phase – is started by the Value Investors. The ‘Smart Money’ begins to aggressively acquire stocks due to their fundamental analysis telling them that the market is trading at a deep discount. This buying absorbs any excess supply and the bottom of the market is established. Even if the economy is bad, it is not as bad as stock prices would suggest and in time the only possible direction is up.

Be fearful when others are greedy and to be greedy only when others are fearful.

– Warren Buffett

B. Phase – The sentiment during this period is of extreme pessimism – “The sky is falling and we are all doomed”. The Smart Money is like a kid in a candy store picking up exceptional companies at bargain prices, often below their intrinsic value. Slowly earnings increase and good news becomes the norm. The General Public is very cautious but begins to accumulate stock under the improving conditions.

C. Phase C can be recognised by record earnings and perfect economic conditions. The general public (with a short memory about how they lost it all last time) starts taking investment advice from their Taxi Driver who just made killing off the latest IPO. Everyone (the general public) is absolutely certain that the market is headed for the Moon.

This escalates into a buying frenzy and dizzying valuations. This alerts the Smart Money to begin moving their money to safer areas in anticipation of the inevitable bursting of the bubble.

Above is a Chart of the Dow Jones Industrial average leading up to the 87 crash with each of the three phases identified.

4. The Averages Must Confirm each other

• Charles Dow utilised two averages in his analysis; The Industrial Average and The Railroad Average (Now the Dow Transportation Index).

In 1900 America was deep into the second Industrial Revolution which ran from about 1870 to 1914. During this time railroads were of supreme importance to the increase of trade throughout the US. James Watt improved on the steam engine making it a viable piece of machinery in the second half of the 18th century. This development helped start the Industrial Revolution.

Steam locomotives allowed for quicker transportation of raw materials that could be used to produce finished goods. The transcontinental railroad was completed in 1869 and the US suddenly had a quick passage from east to west. A journey that used to be a 4 – 6 month trek could now be accomplished in just six days!

According to Dow’s Theory, a bull market in industrials could not occur unless the railway average rallied as well. This logic is very sound; railroad companies can only prosper when the economy is flourishing and increasing quantities of goods are being transported. If the rail road stocks are struggling then manufactures must be producing less. This made rail road stocks extremely economically sensitive.

Dow created the Industrial Average to be like a measure of the tide on one part of the beach, and the Railroad Average was a measure on another part. Used in conjunction they helped to determine that the tide was indeed coming in or going out all along the seashore, rather that being tricked by rogue waves on one part of the beach.

Both averages must make higher highs to confirm a bull market and vice versa. When the performance of the two averages diverge it is an indication of a change in the tide.

5. Volume Confirms the Trend

• Dow noted that volume should expand in the direction of the trend. Stronger volume should be seen on the days that the market is up in a bull market and down in a bear market.

6. The trend remains intact until a confirmed reversal

• A bullish trend can be described as consecutive higher highs and higher lows. To change to a bearish trend it is necessary to have at least one lower high and a lower low. This trend change must then be confirmed by the Railroad Average to have the greatest chance of continuing.

The Dow Theory and how it relates to us today

For a theory written over 100 years ago about technical analysis it is amazing how timeless the principles are and how valid they remain. An understanding of these few principles is an invaluable foundation to effective technical analysis. The major difference today is that we have moved out of the industrial age into the information age.

The Information Age has created a smaller, more integrated world, we already have the ability to work as a unit in real time. Communication, trade, employment, personal and commercial transactions are now occurring on a global scale. Largely, international and regional boundaries are being ignored; capital now flows far more freely between countries.

Profits in the industrial age came from economies of scale; factories and assembly lines. Now profits come from speed of innovation and the ability to attract and keep customers. In the new economy information is often the currency and the product.

In 1901 the biggest company in the world was U.S Steel with a market cap of approximately 35 billion in today’s dollars. Now, we have companies like Google that provides an electronic information service with no physical product. In November 2007 Google had a market cap of over 220 billion.

Technology is at the forefront of the business cycle and semiconductors are at the forefront of technological advancement. All expansion requires semiconductors and any slowdown causes an expensive build up in inventory. Inventory that has a very short shelf life causing the semis to feel the burn as soon as the business cycle begins to slow (a huge build up of inventory was seen in 2000).

Semiconductors are the rail roads of the information age and are extremely economically sensitive. That is why they play such an important part in identifying the markets true direction through a process I call ‘Holistic Market Analysis’. This is the process used in the weekly ETF HQ Report.

Trading Psychology – Group Intelligence

Group Intelligence is a type of synergistic IQ where the collective IQ of the group (assuming that the participants have little emotional connection) becomes greater that any of the individuals on their own.

Group Intelligence as a part of trading psychology is the basis of the ‘Efficient Market Hypothesis’. It assumes that at any given time, security prices fully reflect all available information making it impossible to beat the market except through luck.^[1] Many studies have been conducted that clearly demonstrate the power of Group Intelligence.

Do you remember the TV show ‘Who Wants to Be a Millionaire?’ By answering correctly 15 multi-choice questions that got successively harder, contestants had the opportunity to go home with up to 1 Million dollars.

Unintentionally every week ‘Who Wants to Be a Millionaire?’ pitted group intelligence against individual intelligence and nearly every week, group intelligence won. When people got stuck they could call a pre-selected person to help answer the question, another option was to poll the studio audience who would cast their votes by computer instantly.

Logic would suggest that the pre-selected ‘smart’ friend who no doubt had access to the internet would be most likely to have the correct answer. As it turned out the ‘smart’ friend was right 65% of the time which is not bad. However the collective answer of the random people in the studio audience who had nothing better to do with their time, was right 91% of the time.^[2]

One of the first recorded examples of this phenomenon is from 1906 when Sir Francis Galton analyzed the entries of an ox-weighing contest at a county fair. In the hope of winning a prize nearly 800 participants paid a six penny fee to enter. Galton discovered the average guess to be 1,197 pounds which was almost identical to the ox’s actual weight of 1,198 pounds.^[3]

The price of the stock market is determined in the same way just on a larger scale: people place their guess on what they think stocks are worth and the average of those guesses determines the clearing price, the point where a willing buyer meets a willing seller.

While the process of a group pricing a stock or identifying the weight of an ox is the same, the influnces on the individuals of the group are very different and so are the results. Guessing the weight of an ox is not an emotionally demanding decision and there is no influence on the decision by the other participants. Guessing the price of a stock however can be a very emotional decision and one that is easily influenced by other members of the group. This is why the ‘Efficient Market Hypothesis’ fails; it does not allow for the distortion caused by emotion. Returning to our definition of the stock market:

The stock market represents the collective human emotional interpretation of all that is known and its subsequent effect on the supply and demand of shares in publicly traded companies.

Collective human emotion causes Herd Mentality which leads to irrational behavior and subsequent inefficient pricing. Yet the collective knowledge, ‘all that is known’ in the absence of emotions (Fear, Greed etc) causes Group Intelligence; synergistic IQ where the pricing of an asset will be extremely close to its true value.

Hypothetical True Value

Above you can see a chart of the Dow Jones Industrial Average going back to the 1930s on a log scale. This example is purely for illustrative purposes but assuming the black line represented the markets true value, the gyrations either side show where fear and greed have caused irrational pricing. By averaging out the performance of the market over time, the extremes of emotion become more obvious.

Most of the time stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble … to give way to hope, fear and greed. – Benjamin Graham

These deviations from fair value are what professional investors and traders are able to exploit because of their ability to remain emotionally neutral in their reasoning. Unfortunately their profits come at the expense of the majority of market participants who follow the crowd and are driven by emotion.

Eventually the market will always correct back to the true value of its underlying companies as a whole. The true returns from a mature market over the long term will never be more than a few percent a year and this is the return that can be expected by the buy and hold investor.

Where have you seen Group Intelligence in action? Do you think that the markets are efficient? Leave your thoughts in the comments section below.

Part 1 – Trading Psychology

Part 2 – Herd Mentality

^ Efficient Capital Markets: A Review of Theory and Empirical Work by Eugene F. Fama, The Journal of Finance, Vol. 25, No. 2, May, 1970, Pages 383-417.
^ Group Intelligence – The Wisdom of Crowds, 2004 by James Surowiecki.
^ Vox Populi by Sir Francis Galton, Scientific Journal – Nature, March 7, 1907 Pages 450-451.

Trading Psychology – Herd Mentality

Herd Mentality results in the dilution of I.Q. by the members of a group. This dilution increases exponentially with the size of the group and the level of emotion common amongst members. Herd Mentality is the reason why a group of people can abandon reason and descend into madness in a way that any individual of the group would not, it is also a major cause of Contagion. For this reason it is essential to maintain your individuality when investing. In doing so you can objectively observe the herd’s behavior and profit from its stupidity.

Herd mentality is not reserved for the stock market; have you ever watched a riot on TV and seen regular people committing terrible acts of violence with a complete disregard for others? This is a reaction to peer pressure which makes individuals act in order to avoid feeling ‘left out’ from the group.

Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one! – Charles Mackay

French sociologist Gustave Le Bon developed a theory called Contagion (different from Financial Contagion). It assumes that crowds exert a hypnotic influence over their members. People find themselves in a situation where they are anonymous and can abandon personal responsibility. They get sucked up in the contagious emotions of the crowd and can be driven toward irrational, often violent action that most isolated individuals would not attempt.^[1] The main flaw in this theory is that crowd behavior is not necessarily irrational.

The crowd is always intellectually inferior to the isolated individual, but that, from the point of view of feelings and of the acts these feelings provoke, the crowd may, according to circumstances, be better or worse than the individual. All depends on the nature of the suggestion to which the crowd is exposed – Gustave Le Bon

Another theory to explain Herd Mentality is called Convergence. It suggests that crowd behavior is a product of the convergence of like-minded individuals; that people who wish to act in a certain way come together to form crowds.^[2] Floyd Allport, a man considered the founder of social psychology said “The individual in the crowd behaves exactly as he would behave alone, only more so.” Convergence theory better explains why not all groups of people behave irrationally but does not explain why some people do things in a crowd that they would not have the courage to do alone.

I agree with both theories in part. My research suggests that it is the underlying emotions of the crowd that hold the key to understanding its behavior. If the emotions are negative such as anger, hate, fear, greed etc. then the resulting behavior is best explained by Contagion Theory. As the negativity and the intensity of the emotions increases the resulting behavior is progressively more animalistic and irrational.

Examples:

The Netherlands Tulip mania 1636–37
New York Draft Riots 1863
The Roaring Twenties and the crash of 1929
The Black Monday market crash October 1987
June 2001 riot by Los Angeles Lakers fans after the Lakers victory over Philadelphia in the NBA Finals
Run on the Bank of England September 2007

Stock market bubbles and crashes are great examples of Herd Mentality and Contagion Theory. They tend to begin and end with extremes of emotion; frenzied buying (Greed) to cause a bubble and then selling in a panic (Fear) to trigger a crash. Otherwise sensible people act against their better judgment.^[3] Individuals don’t want to be ‘left out’ and rush with the crowd into or out of the market.

The crimes of Nazism are not the crimes of one nation. Cruelty a taste for violence, the religion of force, ferocious racialism, are not the prerogative of a period or of a people. They are of all ages and of all countries. They have biological and psychological bases which it is by no means certain that we shall escape again. The human being is a dangerous wild animal. In normal periods his evil instincts remain in the background, held in check by the conventions, laws and criteria of civilization, but let a regime come that not only liberates these terrible impulses but makes a virtue of them, then from the depths of time the snout of the beast reappears, tears aside the slender disguise imposed by civilisation and howls the death-cries of forgotten ages – Jacques Delarue (The History of the Gestapo)

However if the underlying emotions are positive such as love, peace, serenity, unity, understanding etc. then the resulting Herd Mentality is better explained by Convergence Theory.

Examples:

The majority of weekly Religious Gatherings
The majority of sporting events
The majority of music concerts
Peaceful Protests

The most significant example of Herd Mentality as explained by Convergence Theory was seen during the Salt Satyagraha. It was a campaign of non-violent protest against the British salt tax in India lead by Mahatma Gandhi. There are reports of over 100,000 people at times marching in a spirit of peace, unity and harmony.^[4] These people were suffering racial and financial injustice and had every reason to be angry yet they remained non-violent.

So what has this got to do with making money in the stock market? Well, it’s the emotions of fear and greed that cause the Wall Street herd to behave irrationally. In contrast; Gandhi, through maintaining positive emotions and resisting anger and fear, induced 200 million people to maintain their composure and act with a clear mind. The result was to bring Britain, a world super power to its knees without any violence or financial backing.

To stay separate from the herd we must remain emotionally neutral, resisting both fear and greed. This is only possible when you know that probability is in your favor. Then you don’t need to care about the outcome of a particular trade, you can remain detached from the outcome and let the law of averages run it course.

If you cannot control your emotions you cannot control your money – Warren Buffett

A fascinating aspect of Trading Psychology is that when the emotional influence on members of a group is low, Herd Mentality evolves into Group Intelligence.

Even the intelligent investor is likely to need considerable willpower to keep from following the crowd. – Benjamin Graham

What tactics do you use to remove emotions from your investing decisions? Have you ever been caught following the crowd?

Part 1 – Trading Psychology

Part 3 – Group Intelligence

^ The Crowd: A Study of the Popular Mind, 1896 by Gustave Le Bon.
^ Sociology, 2007 by John J. Macionis.
^ Herd mentality rules in financial crisis by Maggie Fox, Reuters September 30, 2008.
^ Gandhi and Salt Satyagraha, 1981 by S. R Bakshi.

animalistic

Trading Psychology – Imperative Foundation For Success

An understanding of Trading Psychology is the imperative foundation for all the other skills required for success in the financial arena.

The inability of the masses to endure the psychological effects imposed by the market is the main reason why Wall St eats them alive and why there is so much money to be made by the emotionally intelligent minority. If you are aware of how psychology drives the market you can stand witness to it and maintain clarity of mind in the face of both jubilation and crisis.

Psychology is probably the most important factor in the market – and one that is least understood. – David Dreman (Author of “The Psychology of Stock Market Success”)

Studying Trading Psychology completely altered my definition of what the stock market is. (Before this realization I nearly whipped out my entire trading account). How you define the market defines how you approach it and the turning point for me came when I began to see the market through the following paradigm:

The stock market represents the collective human emotional interpretation of all that is known and its subsequent effect on the supply and demand of shares in publicly traded companies.

If it were not for human emotion then all investments would be perfectly priced, the markets would be efficient and it would be impossible to beat the average return. In reality the market is driven by the twin emotions of Fear and Greed. When prices are rising, greed is the dominant emotion. When prices are falling, fear is the dominant emotion. Notice that logic is not a factor in the equation.

I’d be a bum on the street with a tin cup if the markets were always efficient. – Warren Buffett

The market consists of two main groups; the Smart Money and the general public. The general public ride on emotion and profit only by luck, while the Smart Money ensure they make decisions based on logic. As a result the Smart Money consistently profit over the long term.

When logic and emotion come into conflict, emotion always wins. If logic was the more powerful of the two then there would be no fat people. Instead the logic of eating adequate portions of food selected on the basis of health and a long life is not as powerful as the feelings/emotions experienced by eating gluttonous amounts of food selected on the basis of taste and convenience.

Valuable insight into Trading Psychology can be gained by studying the market during booms and busts because these are the times when it’s effects are most obvious. Huge groups of people will ignore their better judgment and seemingly go insane. Do you remember the height of the Dot Com boom; Oct 1999 – Feb 2000?

This is from the prospectus of VA Linux’s IPO – November, 1999: (now SourceForge, Inc. LNUX)

We incurred losses of $14.5 million in fiscal 1999 primarily due to expansion of our operations, and we had an accumulated deficit of $29.9 million as of October 29, 1999. We expect to continue to incur significant … expenses… We do not expect to generate sufficient revenues to achieve profitability and, therefore, we expect to continue to incur net losses for at least the foreseeable future. If we do achieve profitability, we may not be able to sustain it.^[1]

Based on this information how would logic suggest the IPO went?

Shares in VA Linux Systems soared eightfold today, setting a new record for the largest first-day gain of any initial public offering. – CNET News^[2]

A first-day price gain of about 700% and a closing price of $239.25^[3] gave Linux a market cap of roughly $9 billion.^[4] It went on to lose $728 million over the next 5 years before turning its first profit of $3.9 million in 2006.^[5] On November 25, 2008 it closed at an all time low of $0.58

Can the market get any crazier than this? You bet… Is was revealed by a Purdue University study that during the Dot Com boom companies could get a 89% jump in their stock price simply by switching to a Dot Com name.^[6]

The price of NEI Webworld, rose almost 1,170% in a day simply because it made news for its involvement in an Internet scam… NEI had no assets and was already in bankruptcy liquidation!!^[7]

In this kind of environment many people lose all self control, get swept up in their emotions and forgo the most basic due diligence into a companies fundamentals. Like in 1999 when AppNet Systems, Inc. filed for an IPO under the symbol APPN, at the time there was a company called Appian Technology, Inc. trading on the NASDAQ OTC Bulletin Board under the same APPN symbol. In a feeding frenzy people started buying shares of Appian technology thinking they were getting AppNet Systems before its IPO. Appian Technology shares went up 142,757% in the two days following the filing. Over 7.3 million shares were traded compared to just 200 shares the day before.^[8]

I can calculate the movement of the stars, but not the madness of men. – Sir Isaac Newton, lost a fortune in the South Sea Bubble

Perhaps the most hilarious examples of the utter madness that humans are capable of when driven by greed were seen during the South Sea Bubble. Capital was raised through stock offerings for, among other things; “a wheel for perpetual motion”^[9] and “The trading of hair”.^[10] But my personal favourite is a prospectus by one audacious con-man entitled:

“A company for carrying on an undertaking of great advantage,
but nobody to knows what it is.”

The man (who nobody has been able to identify) simply stated that the required capital was half a million. Just 5 hours after opening the doors for the IPO he had raised £2000. Then, that evening, displaying infinitely more intelligence than the people he had just robbed, he set sail for the new world (America) and was never heard from again.^[11] He knew enough about the psychology of trading to see the bubble and prey on those blind with greed.

Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities – that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future – will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.^[12] – Warren Buffett

This irrational behavior by people riding on emotion opens the door of profit to those that understand trading psychology. Crooks use it as an opening for their underhand tactics but the lasting profits are to be enjoyed by emotionally intelligent traders and investors.

It is important to distinguish between the Psychology of the individual and that of the crowd. It is not possible for large numbers of individuals to reach such extremes of irrational behavior simultaneously. This only occurs when individualism is lost and ‘Herd Mentality‘ takes over.

What examples of madness have you witnessed in the the market? Have you ever missed opportunities or made regrettable investments under the influence of emotion? Share your experiences in the comments section below.

Part 2 – Herd Mentality

Part 3 – Group Intelligence

^ VA Linux Systems, Inc. IPO filed with the SEC November 17, 1999. Page 7; Risk Factors, Paragraph 2; We have a history of losses and expect to continue to incur net losses for the foreseeable future.
^ VA Linux storms Wall Street with 698 percent gain by Dawn Kawamoto and Stephen Shankland, CNET News December 9, 1999.
^ VA Linux storms Wall Street with 698 percent gain by Dawn Kawamoto and Stephen Shankland, CNET News December 9, 1999.
^ Meeting of the Federal Open Market Committee December 21, 1999. Page 12, Paragraph 2.
^ SourceForge Inc: Financial Statement, Income Statement – 10 Year Summary (in Millions).
^ A Rose.com by Any Other Name by: Cooper, Michael J; Dimitrov, Orlin; Rau, P. Raghavendra. The Journal of Finance, Volume 56, Number 6, Page 2379, Paragraph 1, December 2001. Department of Finance, Krannert School of Management, Purdue University.
^ In the wild world of Internet postings, sometimes bad news is good news by Rebecca Buckman, The Wall Street Journal, December 17, 1999.
^ Mistaken ID takes stock for a ride Briefly shared symbol caused AppNet mix-up by Terzah Ewing, The Wall Street Journal, May 9, 1999.
^ Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, Volume I, 1852 by Charles Mackay, LL.D. Chapter 2 The South-Sea Bubble, List of Bubbles, Page 58, #36.
^ Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, Volume I, 1852 by Charles Mackay, LL.D. Chapter 2 The South-Sea Bubble, List of Bubbles, Page 57, #14.
^ Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, Volume I, 1852 by Charles Mackay, LL.D. Chapter 2 The South-Sea Bubble, List of Bubbles, Page 53, Paragraph 2.
^ Chairman’s Letter 2000, Berkshire Hathaway, Page 14, Paragraph 2.

Buy and Hold is not Dead – It was NEVER Alive

After the crash of 2008, many peoples faith in the Buy and Hold approach to financial freedom is on shaky ground. For a long time the Buy and Hold strategy has been pushed strongly by financial planners and the mutual fund industry.

To sell ‘Buy and Hold’ as the way to go, compelling statistics are produced about how historically stocks have outperformed other asset classes. How despite a few ‘bumps’ along the way “over the long term you can’t lose”.
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Buy and Hold

But never take anything that you have been told as fact until you have done your own research (especially when it involves your finances). As you are about to see, the reality is that Buy and Hold is not dead, it was never even alive and was simply dreamed up as a marketing ploy by those who would stand to profit from your believing in it. Perhaps a better description would be Buy and Pray.
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What is the Average Stock Market Return?

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When people talk about returns available for the Buy and Hold investor they generally quote the historical performance of the US market, specifically the Dow Jones Industrial Average. Several ‘Experts’ have told me that the average stock market return you can expect is 8 – 15% per year. To quote from ‘Money Secrets of the Rich’ by John Burley printed 1999:
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…compounded returns averaging more than 14%+ over the last 45 years…^[1]

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This is such a half truth it is a lie! To mislead people into believing that by simply using a Buy and Hold strategy they will achieve returns of this nature is irresponsible!

Over time Buy and Hold returns on a broad index like the S&P 500 will match the average earnings yield and GDP growth. Robert D. Arnott and Peter L. Bernstein found that the real stock returns over the past 192 years averaged 6.1% derived from three components; an earnings yield of 5%, per capita GDP growth of 1.7%, less 0.6% shrinkage of dividends relative to real per capital GDP growth.^[2]

From 1929 to 2008 I calculate the average stock market return on the Dow Jones Industrial Average at just 4.28% without allowing for inflation. That is far short of the 8-15% that most Buy and Hold investors promote as the investment returns that can be expected. The scary thing is that people are basing retirement projections on such forecasts; for the 380 companies in the S&P 500 with defined-benefit plans, projected returns average 9%.^[3]
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The U.S Was a Top Performer

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Another misleading factor is that during the 20th century the US had the worlds 4th best performing stock market after inflation.^[4] This history of stellar growth in the US is something that we take for granted but it is unlikely to continue. With no intention of being anti American I am simply stating a fact based on historical trends that it will be very difficult for the US market to be one of the top global performers during the 21st century.

Time brings many changes, 2000 years ago China and India combined accounted for 59% of the worlds GDP. By 1950 Western Europe and the US had taken command with 53.5%.^[5] That hold has since slipped and over the last 55 years China and India have grown their share of the words GDP from 8.75% to 22.07% (1950-2005), while the US and Western Europe now account for 38.24%.^[6]

The next 50 years are likely to bring change at a faster pace than at any other time in history and it will put to test the US’s commitment to the global trade system. The rising forces of China and India will cause disruptions to workforces, industries, companies, and markets in ways that we can only begin to imagine. In the 19th century, Europe had to go through a similar test when it realized that a new giant was emerging; the US. World leading corporate strategist Kenichi Ohmae said:
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It is up to America to manage its own expectation of China and India as either a threat or opportunity.

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As long as calamity doesn’t strike, most economists predict that China and India have the ability to keep growing at an annual rate of 7-8% for decades because they have younger populations, higher savings rates, and so much catching up to do.^[7] At current projections China is likely to take the No. 1 position from the US and become the world’s largest economy before 2020.^[8] By then, China and India could account for half of global GDP. If this takeover does occur then a Buy and Hold strategy on the US market is going to produce disappointing results.

Warren Buffett put the reality of the situation brilliantly in his 2007 letter to Berkshire Hathaway Inc. shareholders:
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During the 20th Century, the Dow advanced … 5.3% when compounded annually … Think now about this century. For investors to merely match that 5.3% market-value gain, the Dow … would need to close at about 2,000,000 on December 31, 2099 … While anything is possible, does anyone really believe this is the most likely outcome? … People who expect to earn 10% annually from equities during this century … are implicitly forecasting a level of about 24,000,000 on the Dow by 2100. If your adviser talks to you about double digit returns from equities, explain this math to him … Many helpers are apparently direct descendants of the queen in Alice in Wonderland, who said: “Why, sometimes I’ve believed as many as six impossible things before breakfast.”^[9]

“Buy and Hold and you can’t lose long term” …But how long is long term?

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Buy and hold advocates constantly remind us that if we hold a diversified portfolio for the long term then we can’t lose. Well, just how long is the long term?

One investment advisor told me that if you Buy and Hold for 20 years or more then your risk in the stock market is reduced to zero. Some say less… This from Mutual of America’s website:
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There has been no 10-year period in the previous 50 years that has resulted in a downtick in the S&P 500.^[10]

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As Benjamin Disraeli said “There are three kinds of lies: lies, damned lies, and statistics.” Mutual of America had revenue of 1.77 billion^[11] in 2008 and they boast of “strong portfolio management teams and significant research capabilities”.^[12] Yet despite their well funded research they can’t do simple maths. Before allowing for inflation there has actually been 6 (and counting) ten year periods over the last 50 years that have resulted in a downtick for the S&P 500 and the Buy and Hold investor:

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Buy and Hold Lie
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So what is the longest period with no growth for the Buy and Hold investor?

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Would you be shocked to hear that the US has had three periods longer than 57 years where the stock market has experienced no real growth including one period of 130 years? Robert Arnott in a stunning article called ‘Bonds: Why Bother?‘, revealed that the market drop from 1929-1932 was so severe that in real terms stocks fell below 1802 levels. This erased 130 years of market gains:^[13]
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Buy and Hold After Inflation

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Why do mutual fund promoters overlook this kind of research and mislead people into thinking that a Buy and Hold strategy is the best way to go? Because they make huge fees out of managing your money and the last thing they want is for you to withdraw your funds in a bear market. At the end of the third quarter 2009, equity mutual funds held $8.53 trillion dollars under management.^[14] That makes promoting the Buy and Hold myth worth HUGE dollars.
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Summary

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Here is a prime example of how in the financial markets more than any other industry, one must be very aware of who is producing the statistics that are being used to influence your thinking. (I am a trader so remember, I have a bias in the way that I present this information as well.)

Unfortunately the fact is that Buy and Hold as a strategy just does not stand up to scrutiny. Having said that, Buy and Hold as a strategy is certainly better than not investing at all. We may even get lucky and see the market embark on another 20 year period of above average growth like we saw from 1980 to 2000 when the S&P 500 advanced over 1200%.

But… you should never rely on luck when it comes to your financial future. The reality is that over the long term the return from the stock market must match the growth of the economy, whatever that ends up being. In the interim stocks undergo a constant battle between what they are truly worth based on the fundamentals and what the irrational, emotional, ‘Greater Fool’ is willing to pay.

If you are to ensure long term success with your finances regardless of what happens in the economy you must have an edge over the market.

Incidentally, if you don’t know what your edge is, you don’t have one. – Jack Schwager

So you have seen my research… Do you still believe in Buy and Hold? Share your thoughts in the comments section below.
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^ Money Secrets of the Rich by John Burley, 1999
^ What Risk Premium is Normal? by Robert D. Arnott and Peter L. Bernstein. Financial Analysts Journal, March/April 2002, Vol. 58, No. 2, Page 74, Paragraph 3
^ The Pension Crisis Revealed, 2003 by Frank Fabozzi and Ryan Ronald. Journal of Investing Volume 12, No. 3
^ Triumph of the Optimists: 101 Years of Global Investment Returns, 2002 by Elroy Dimson, Paul Marsh, Mike Staunton. Page 52, Table 4-1
^ Contours of the World Economy 1-2030 AD Essays in Macro-Economic History, 2007 by Angus Maddison. Page 261, Table 8b
^ Statistics on World Population, GDP and Per Capita GDP, 1-2006 AD, March 2009, Horizontal File
^ Why the world must watch out for India, China by Pete Engardio. Businessweek September 12, 2005
^ China’s Economic Performance: How Fast Has GDP Grown; How Big is it Compared With The USA? February 22, 2007 by Angus Maddison and Harry X. Wu. Page 1, Paragraph 1
^ To the Shareholders of Berkshire Hathaway Inc. February 2008 by Warren E. Buffett. Fanciful Figures – How Public Companies Juice Earnings, Page 19, Paragraphs 3-8
^ Mutual of America, Capital Management Report, Stocks, S&P 500, Paragraph 3 (Screen Shot)
^ Mutual of America 2008 Annual Report, Financial and Corporate Information, Consolidated Statutory Statements of Operation and Surplus, Page 51
^ Mutual of America 2008 Annual Report, Discipline, Page 19
^ Bonds: Why Bother? May / June 2009 by Robert Arnott, Rethinking Fixed Income. Page 2 Paragraph 7
^ Worldwide Mutual Fund Assets and Flows, Third Quarter 2009, Worldwide Assets of Equity, Bond, Money Market, and Balanced/Mixed Funds. Billions of U.S. dollars, end of quarter.

The World Economy Makes Contagion Go Round

Contagion is a concept that not many people are familiar with but it’s a very real, powerful and important force in our financial markets. We see contagion in effect every time a reaction in one market spreads into another. As Gordon Brown, ex-Chancellor and Prime Minister of Britain said:

. Contagion

No matter where it starts, an economic crisis does not stop at the water’s edge. It ripples across the world… Modern communications instantly span every continent. The new frontier is that there is no frontier, the new shared truth is that global problems need global solutions.^[1]

A vast amount of research into this interrelationship has been undertaken but still very little is really known about its causes. Unfortunately much of the information available on the subject is in the form of complex academic papers. In this article I attempt to briefly and simply cover what contagion is and what’s known about its major causes.

Definitions for contagion vary greatly and range from the broad:

Contagion is the cross-country transmission of economic shocks.

To more restrictive definitions:

Contagion is the transmission of financial shocks from one country to another that can not be explained by any fundamental or rational link.

My research suggests that contagion has many causes and find both definitions too restrictive. Examples of this phenomenon can be seen in good times and bad. Not just when shocking news is released such as a downward revision of GDP growth or a prolonged crisis like the credit crunch of 2008 (although situations like this do appear to amplify the effect).

Because contagion occurs in both bull and bear markets and has many different causes, I have given it the following very broad definition:

Contagion is the cross-country correlation of financial markets due to one or a combination of factors including: Margin Calls, International Counterparty Risk, Fundamental Links, Cross-Market Hedging and Herd Mentality.

Exactly which cause is responsible for contagion in each situation is difficult to prove but evidence suggests that it usually results from a combination of factors. I will cover the top five factors followed by a case study and summary of my research:

Margin Calls
International Counterparty Risk
Fundamental Links
Cross-Market Hedging
Herd Mentality

Case Study
Summary

1. Margin Calls

Margin calls can lead to contagion when two economies are connected by investors with holdings in both. News that leads to a drop in asset prices in Country ‘A’ can trigger margin calls that are met by the forced selling of assets held in Country ‘B’ even though Country ‘B’ may not be affected directly by the news.

Panic selling by hedge funds has emerged as the hidden cause of the contagion spreading through the global financial system. – UK Telegraph^[2]

In August 2007 Goldman Sachs’ 9 billion^[3] dollar hedge fund ‘Global Alpha’ saw its assets decline 22.5%. Was this because of exposure to mortgage backed CDO’s like so many other hedge finds that were running onto trouble? No, Global Alpha’s losses in that month came from positions in currencies like the Japanese Yen and the Australian Dollar as well as stocks holdings in the US, Norway and Finland.^[4]

As the housing market went south the funds that were exposed to toxic CDO’s needed to raise cash to meet margin calls. However redemption of these bad assets was almost impossible because the market for them had become illiquid and frozen. In a panic they were forced to close out of positions they had in more liquid assets. This caused declines in stocks around the globe and unusual behavior on the foreign exchange markets.^[5]

At the time Global Alpha was leveraged 6 to 1 and when the market started to behave in a way that the funds computer models had not expected it started to experience significant losses. This intern triggered more margin calls for Global Alpha forcing another cycle of selling on assets not directly affected by the original turmoil.^[6] Here you can clearly see how margin calls can set off a domino effect of more margin calls which lead to contagion on unrelated assets around the globe.

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2. International Counterparty Risk

If an institution in one country has obligations through the likes of debt, derivatives, or insurance in another country then its demise will have a global impact. No example of this is more profound than that of troubled insurance giant AIG. In early 2009 they held roughly 74 million insurance polices, issued in more then 130 countries.^[7] The notional value of their derivatives portfolio was approximately 1.6 trillion covering a counterparty base of over 1,500 clients. These clients included top banks, wealth finds, major corporations, governments and institutional investors.^[8]

Due to its integral position in the functioning of the global financial system Sen. Christopher Dodd, chairman of the Senate Banking Committee described AIG as having the “world financial system by the throat”.^[9] The US Federal Reserve Chairman, Ben Bernanke deemed them “too big to fail”, saying such large, interconnected financial firms pose a “systemic risk” to economic stability.^[10]

The failure of a company like AIG would cause turmoil in the U.S. economy and global markets, and have multiple and potentially catastrophic unforeseen consequences. This is a prime example of how counterparty risk can cause contagion in financial networks.

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3. Fundamental Links

Fundamental links are the most obvious and easy to understand causes of contagion. These links are usually the result of international trade where two countries trade with each other or compete in the same foreign market. A drop in the currency valuation of Country ‘A’ will eat into the competitive advantage of Country ‘B’, the likely consequence being that both Country ‘A’ and ‘B’ will end up devaluing their currencies to re-balance their external sectors.^[11]

Some fundamental changes have a global impact, such as fluctuations in the price of oil. Others financial links are the result of a direct investment by one country in another. In December 2009 China held $755.4 Billion dollars of US Treasury Securities which was 21% of the total outstanding.^[12] In 2009 The US also did $365.98 billion^[13] in trade with China of which $266.8 billion was a deficit.^[14] It is clear to see how the US and China are fundamentally joined at the hip and how this will lead to contagion between the two.

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4. Cross-Market Hedging*

Many global investment managers aim to keep their portfolios optimally hedged at all times. When a change is required due to the release of new information about macroeconomic risk factors or simply a change in asset prices this will alter the global balance of their portfolio. The required re-balancing transmits the effect from the source market to the other markets in their portfolio causing a correlation or contagion over the short term.^[15]

*I have used the term hedging instead of rebalancing (as used in “A Rational Expectations Model of Financial Contagion”^[15]) because rebalancing can occur for several reasons, only one of which is cross-market hedging.

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5. Herd Mentality

Herd Mentality is the result of a reaction to peer pressure which makes individuals act in order to avoid feeling ‘left out’ from the group.

French sociologist Gustave Le Bon developed ‘Contagion Theory’ (different from Financial Contagion). It assumes that crowds exert a hypnotic influence over their members. People find themselves in a situation where they are anonymous and can abandon personal responsibility. They get sucked up in the contagious emotions of the crowd and can be driven toward irrational, often violent, action that most isolated individuals would not attempt.^[16] However the main flaw of this theory is that crowd behavior is not necessarily irrational.

On the investment landscape people are notorious for acting in herds and those investing abroad are often the worst offenders. It is very hard for an investor to understand all of the economic factors in their home market let alone a foreign one. Rather than basing their decisions on fact, many will allow their decisions to be affected by the action they witness in the surrounding markets, regardless of any fundamental link.

For instance Indonesia was the worst affected economy in the Asian crisis, which is surprising because they had comparatively sound macroeconomic fundamentals. They had the highest economic growth in Southeast Asia, low inflation, a modest current account deficit, rapid export growth and growing international currency reserves.

Fundamentals alone do not explain the severity of the Indonesian problems in 1997. Indications are that contagion of the more real crisis occurring in Thailand caused the crisis to spread to Indonesia. What was happening in Thailand lead international investors to reassess Indonesia’s economic performance. Rather than base their decisions on real links, people just followed the Herd. This facilitated the contagion effect by fueling a spread of fear from Thailand to Indonesia leading to illogical declines in asset values.^[17]

Herd Mentality helps to amplify and perpetuate other causes of contagion as well. Good news that has a rational fundamental link between Countries ‘A’ and ‘B’ can be over compensated for due to the spread of greed throughout the Herd; no one wants to miss out on the rally. This greed can then spread through the Herd to Countries ‘X, Y and Z’ that lack a fundamental link to the original good news. Fear appears to spread around the globe much more effectively than greed however, and the resulting ‘death spiral’ can be difficult to stop. This is all typical of Herd Mentality; it helps spread panic and irrational exuberance around the globe.

The five causes I have mentioned appear to be the main causes of Financial contagion and each can be observed in many instances as having a measurable impact. However it is unlikely that we will ever been able to measure the relative importance of each cause and it appears as though the role each plays varies from case to case.

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Case Study

A prime historical example of contagion can be seen by the effect that the Russian bond default had on Brazil. But how much of the reaction toward Brazil after the 1998 crisis in Russia was due to margin calls and how much was due to the Herd Mentality facilitating the spread of panic?

Despite support from the International Monetary Fund, in August 1998 Russia defaulted on its sovereign debt, devalued the ruble, and declared a suspension of payments by commercial banks to foreign creditors.^[18] During this crisis the asset prices in Russia, Brazil, and the US despite having little fundamental relationship to each other, exhibited the following common patterns:^[19]

Market depth and liquidity decreased simultaneously.
The volatility of prices increased simultaneously.
The correlation of prices on seemingly independent positions increased.

For reasons no one appears to be able to agree on, the Russian devaluation prompted a capital flight from Brazil and eventually a significant loss in value of its currency.^[20] The concept of contagion was on vivid display in perhaps its most logic-defying form. For some reason the spreads on Russian and Brazilian Brady Bonds and reserves during this period became remarkably correlated.^[21]

The Russian contagion to Brazil crossed international borders to a country with a very different economy. Countries with fundamentals closely matching Russia’s did not experience a financial crisis so why would the events in Russia affect Brazil so profoundly? Brazil’s economy was much bigger than Russia’s^[22] and was more likely to benefit from low-oil prices than to suffer as Russia had. Nevertheless, the implosion of the Russian economy caused massive financial problems in Brazil.

There has never been such a pronounced example of market contagion where the markets that are less fundamentally related. Was this due to fear, margin calls, cross-market hedging or something else? It is hard to say but no one can deny that contagion occurred in a way that is impossible to quantify with the current model for economic logic.

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Summary

The power of contagion has been growing steadily for the last 20 years thanks to globalization and the growing speed and availability of information. Today, in the Information Age we live in a smaller, more integrated world and we look set to continue to move towards a truly global economy. Already we have the ability to work as a unit in real time. Communication, trade, employment, personal and commercial transactions are now occurring on a global scale. Largely, international and regional boundaries are being ignored;^[23] capital now flows far more freely between countries.^[24]

In some ways this globalization helps to stabilize things and prevent another world war. To go to war with countries that you depend on for trade and are so heavily invested in would be economic suicide. In other ways it means that when a recession occurs there are few areas that are not effected making it very hard to find a safe haven for your capital.^[25]

All of this leads to more contagion; it is real and will continue to have an impact on the financial landscape for a long time to come.

Have you seen the effects of contagion on your finances? What do you think the causes were? Please share your thoughts in the comments section below.

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^ New global deal needed to tackle recession, says Brown, Isish Times, March 5, 2009 by Denis Staunton
^ Hedge fund panic was behind global stock markets collapse, UK Telegraph, August 11 2007 by Helen Power and Dan Roberts
^ Did Genius Fail Again at Goldman Sachs’ Global Alpha Fund?, Seeking Alpha August 14, 2007 by Michael Shedlock
^ Goldman’s Global Alpha Fund Fell 22 Percent in August (Update3), Bloomberg, September 13, 2007 by Jenny Strasburg and Katherine Burton.
^ Quant Bloodbath Revisited, Lehman Brothers Stategist Becomes The Sage of The Subprime Contagion Theory, Deal Breaker, August 13, 2007 by John Carney.
^ Blowing up the Lab on Wall Street, Time – Business & Tech, Thursday, Aug. 16, 2007 by Richard Bookstaber, Paragraph 6
^ US takes another crack at AIG rescue, March 3, 2009 CNN Money
^ AIG: Is the Risk Systemic? Draft, March 6, 2009 Prepared by American International Group, Inc.
^ ‘Too big to fail’? More like ‘too unknown and scary to fail’, March 15, 2009 Los Angeles Times
^ Bernanke: Fix banks to get a recovery, CNN Money, March 10, 2009
^ An Evaluation of the Devaluation by Sam Vaknin, Ph.D.
^ Major Foreign Holders Of Treasury Securities, December 2009
^ Top Ten Countries with which the U.S. Trades, December 2009
^ Top Ten Countries with which the U.S. has a Trade Deficit, December 2009
^ A Rational Expectations Model of Financial Contagion, April 19, 2001 by Laura E. Kodres and Matthew Pritsker. Part III Contagion Through Cross-Market Rebalancing, Pages 15-23
^ The Crowd: A Study of the Popular Mind, 1896 by Gustave Le Bon
^ Indonesia’s Economic Crisis: Contagion And Fundamentals. The Developing Economies Volume 40 Issue 2, Pages 135 – 151 March 6, 2007 by Reiny Iriana And Fredrik Sjöholm
^ Russia and Brazil: Two defenseless giants, January 19, 1999 by Sergei Blagov
^ Contagion as a Wealth Effect by Kyle, Albert S. and Wei Xiong, 2001. Journal of Finance, Vol 56, Iss. 4, pages 1401-1440
^ Brazil crisis underlines the need for new solutions by Martin Khor
^ The Russian Default And The Contagion To Brazil, 2000 by Taimur Baig And Ilan Goldfajn. Page 8, Figure 1
^ Chapter 1 Current State of the World Economy, Section 1: Overview of the World Economy, Table 1-1-1
^ Speech at Credit Suisse First Boston Asian Investment Conference, March 26, 1999. International Capital Flows and Free Markets by Joseph Yam, JP Chief Executive Hong Kong Monetary Authority. Conclusion
^ The Economics of Developing Nations and the Global Financial Crisis, Thought Economics – Business & Strategy for “Economy 2.0” 15 December 2008 by Vikas Shah. Paragraph 1
^ A recession of global dimensions? – Globalization is a wonderful thing for the U.S. economy. It’s also driving the dramatic slowdown that’s underway. January 22, 2008 by Geoff Colvin